I am covering a few topics today, given that I used yesterday's post space to…
Apparently, whenever some poor economic news is published about the United Kingdom, journalists have to weave in their on-going gripe about the outpouring of democracy in June last year that saw the Brexit vote to leave successful. Its hysterical really. The most recent example is from the otherwise sensible Aditya Chakrabortty from the UK Guardian (October 17, 2017) – Who’s to blame for Brexit’s fantasy politics? The experts, of course. The story has nothing much to do with the June 2016 Referendum but more about massive forecasting failures of the Office of Budget Responsibility. But somehow the story opines about the lies told about Brexit and a fiscal “bloodbath” – the latter being the description for the fact that the fiscal deficit is likely to increase a little as a result of a slower than expected economic growth outcome. The UK Guardian continually writes about these two obsessions – the first that Brexit will be a disaster and the second that the fiscal position of the British government is in jeopardy and will undermine the capacity of the government to defend the economy if a major downturn comes along (as a result of the ‘Brexit disaster’). The narratives are interlinked – Brexit is bad, it will cause deficits to rise which are bad, and the government will be powerless as a result of the rising deficits to stop the bad consequences of Brexit – which is a big bad. All propositions are largely nonsense. Brexit will be bad if the British government continues to implement neoliberal policy. Rising deficits do not alter the spending capacity of government. And as a currency-issuing government, Britain can always arrest a recession, if there is political will. The fact is that the OBR forecast errors are just part of the neoliberal lie. And the productivity growth slump the OBR has now ‘discovered’ predates the Brexit referendum by years and is all down to the misplaced austerity imposed by George Osborne in June 2010. But it is disappointing to read this sort of stuff being repeated by so-called progressive commentator. There is clearly more work to be done via education.
The UK Guardian article (October 17, 2017) – Who’s to blame for Brexit’s fantasy politics? The experts, of course – Aditya Chakrabortty focuses on the latest – Forecast evaluation report – October 2017 – (FER) issued last week (October 10, 2017) by the British Office of Budget Responsibility.
This is an annual report, “published each autumn, examines how our forecasts compare to subsequent outturn data and identifies lessons for future forecasts”.
The OBR Press Release (October 10, 2017) – Deficit falls, but productivity growth disappoints again – discloses that:
1. “Real GDP growth in the period up to mid-2017 was weaker than predicted in both our March 2015 and March 2016 forecasts, but nominal GDP growth – which is the more important driver of the public finances – fell short of our March 2015 forecast by a smaller margin while it actually exceeded our March 2016 forecast”.
2. “One recurring theme in past reports has been productivity falling short of our forecasts (Chart 1.1) while employment and average hours worked have exceeded them.”
The following graph reproduced from the OBR October FER shows the sequence of productivity forecasts from the OBR starting with the estimates from the FER October 2010 through to March 2017 together with the actual productivity performance (black line).
They clearly were desperate to hang on to belief that the return to the pre-2011 trend would come anytime soon – except it didn’t and so ‘anytime soon’ kept getting pushed out.
Even in March 2017, just 6 months or so ago, they were making the same mistake.
Here is a longer time series – from the first-quarter 1975 to the June-quarter 2017 – for output per hour worked. The same sort of pattern emerges if we use the output per person employed measure.
The cyclical swings throughout this extended period are evident and the size of the GFC downturn is highlighted within the red-rectangle.
The point is that something connected with the GFC has led British labour productivity to flatten out. And the cause of the productivity slump is not related to the Brexit referendum, despite what the ‘Remain Cheer Squad’ would have you believe.
Structural explanations of this slump are also unlikely to have traction. The massive cyclical contraction pushed British productivity growth of its past trend. Structural factors work more slowly and we would not witness such a fall if they were implicated.
OBR has clearly made a series of major forecasting errors in terms of how quickly the economy was growing.
It is now clear that:
Actual productivity growth averaged 2.1 per cent a year in the pre- crisis period, but has averaged just 0.2 per cent over the past five years.
Even in March 2017, OBR forecast productivity growth to read 1.8 per cent by 2021, but now admit that they will be “reducing our assumption for potential productivity growth over the next five years”.
The two elements to their forecasting mistakes are:
1. Real GDP growth was well below OBR estimates. This shortfall has been dominated by “the weakness in business investment”, which I will consider soon.
2. Employment growth has been “stronger-than-expected” and “hours worked” have grown more than OBR thought – by some margin.
GDP is the numerator and some measure of employment (hours or persons) forms the denominator of the productivity measures. So, taken together, productivity growth turns out to be well below what they forecast.
So OBR misread all elements.
The next graph shows the UK investment ratio (total capital formation as a percent of GDP) from the March-quarter 2005 to the June-quarter 2017.
The drop associated with the GFC is quite stunning. It went from 20.1 per cent of GDP in the December-quarter 2007 to 16.5 per cent by the December-quarter 2009.
That is a huge cyclical swing and tells us how deep the GFC recession was in the UK. Real GDP growth was negative for 5 successive quarters starting in the June-quarter 2008. The British economy shrunk by 6 percentage points between the March-quarter 2008 to the September-quarter 2009.
Why would that cause productivity growth to slump then fail to recover?
A major driver of productivity is investment – both public and private.
While business investment is cost sensitive (so may respond to interest rate changes), mainstream economists usually ignore the fact that expectations of earnings are also important as are asymmetries across the cycle.
Cyclical asymmetries mean (in this context) that investment spending drops quickly when economic activity declines and typically takes a longer period to recover. So fast drop and slow recovery.
The cyclical asymmetries in investment spending arise because investment in new capital stock usually requires firms to make large irreversible capital outlays.
Capital is not a piece of putty (as it is depicted in the mainstream economics textbooks that the students use in universities) that can be remoulded in whatever configuration that might be appropriate (that is, different types of machines and equipment).
Once the firm has made a large-scale investment in a new technology they will be stuck with it for some period.
In an environment of endemic uncertainty, firms become cautious in times of pessimism and employ broad safety margins when deciding how much investment they will spend.
Accordingly, they form expectations of future profitability by considering the current capacity utilisation rate against their normal usage.
They will only invest when capacity utilisation, exceeds its normal level. So investment varies with capacity utilisation within bounds and therefore productive capacity grows at rate which is bounded from below and above.
The asymmetric investment behaviour thus generates asymmetries in capacity growth because productive capacity only grows when there is a shortage of capacity.
This insight has major implications for the way in which economies recover and the necessity for strong fiscal support when a deep recession is encountered.
These dynamics are covered in my 2008 book with Joan Muysken – Full Employment abandoned.
In some of my earlier work (with Joan Muysken) – for example, here is a working paper you can get for free (subsequently published in the literature) – we developed a model based on the notion that investors facing endemic uncertainty make large irreversible capital outlays, which leads them to be cautious in times of pessimism and to use broad safety margins.
The problem of asymmetry can be attenuated if government steps in during a downturn and arrests the spending collapse. Appropriate fiscal stimulus initiatives can thus shorten any non-government spending declines and limit the investment slump.
This not only shortens the decline into the activity trough but also means that potential output growth can be maintained at previous rates.
The opposite is of course also the case.
Imposing pro-cyclical fiscal austerity of the scale that George Osborne initiated when the Tories came took government in May 2010 is the last thing a government should do when non-government spending is in retreat.
Fiscal austerity in these circumstances exacerbates the typical asymmetry associated with investment expenditure and is a major reason why business investment in the UK has been so weak.
We often focus on the short-term negative impacts of fiscal austerity, but in this case, it also has serious long-term impacts on both the rate of business investment and the potential growth rate (which falls as capital formation stalls).
The longer it takes for business investment to recover, the worse will be the long-term impact on potential GDP growth. In turn, this means that the inflation biases are increased because full capacity is reached sooner in a recovery – often before all the idle labour is absorbed.
So, while George Osborne is long gone, the negative impacts of his policy folly will reverberate for a long time to come. His failings will continue on for many years and the flat productivity growth is one manifestation of that failing.
The media focus seems to have ignored this issue and instead is emphasising the impact on the fiscal balance.
The UK Guardian article (October 10, 2017) – UK productivity estimates must be ‘significantly’ lowered, admits OBR – focuses on this issue.
They write that the productivity “downgrade”:
… will wipe out about two-thirds of the government’s £26bn budget surplus from 2017 to 2021. The stockpile, seen as a war chest for a potential slowdown after a disorderly and harmful EU exit, was set aside by the chancellor in the previous budget in March.
Hammond is under pressure to increase spending, despite weaker economic readings.
That little piece of prose is riddled with neoliberal myths.
1. A fiscal surplus does not constitute a “stockpile” or a “war chest” that can help the government spend more later.
2. What logic is there in the statement that “Hammond is under pressure to increase spending, despite weaker economic readings”? The responsible position is exactly the opposite – Hammond should increase spending because of the weaker economic readings.
Even the likes of Aditya Chakrabortty is pushing the line that the fiscal position is in jeopardy as a result of the poor productivity growth.
In the article cited in the Introduction, he writes in relation to OBR’s revisions:
Now it has had to admit reality – and that will mean our forecast growth rates now halving and the public finances heading for what officials term a “bloodbath”. In other words, if Hammond sticks to his austerity plan, you can expect the cuts to our disability benefits, schools and hospitals to drag on for even longer.
Why would a so-called progressive journalist use the language of the “officials” – to wit, “bloodbath” when describing the cyclical impacts on the tax take by government.
So what if the fiscal deficit rises? Is that a “bloodbath”? Clearly not.
It is highly likely that as the economy slows the fiscal position of the British government will move towards a higher deficit as the tax components tied to non-government economic activity yield lower flows and government welfare payments rise.
That doesn’t reduce the capacity of the government to spend. In fact, as noted above, it tells the government it should increase discretionary expenditure to get the economy going again.
Whether the Chancellor Hammond gets that is another question. But progressives should not be buying into the idea that a rising deficit is a “bloodbath” or that fiscal surpluses somehow provide the government with more spending capacity in the future.
The productivity slump is down to the fact that that both sides of British politics have failed to articulate a growth strategy where the public sector creates and supports an environment where non-government investment expectations are optimistic and households can save more given their precarious debt situation.
The whole growth strategy since 2010 has relied on ever-increasing private debt as government try to achieve fiscal surpluses. Exactly the opposite to what is required.
Whether Brexit turns out to be a bad thing for the UK will not be the result of severing ties with the corrupt and dysfunctional European Union. It will all be down to the policy positions that the British government takes.
If it persists with its neoliberal obsession of pursuing fiscal surpluses, then the outcomes are likely to be bad. If not, otherwise.
For British Labour, the choice is the same. Continue to rave on about fiscal rules (as if they define responsible policy) or grow up and recognise the intrinsic capacities its had as the currency-issuer to create strong employment growth and first-class public infrastructure – both of which crowd in private investment.
That is enough for today!
(c) Copyright 2017 William Mitchell. All Rights Reserved.